MARCH 22, 2016

By S Sivakumar, LL.B., FCA, FCS, ACSI, MBA, Advocate

WITH effect from 1-4-2016, in Rule 6 of the CCR, 2004, Sub-rules (2), (3), (3A) and (3B) have been substituted, in terms of which, a manufacturer/provider of taxable and exempted services shall pay an amount equal to 6%/7 % of the value of the exempted services subject to a maximum of the total credit available in the account of the assessee at the end of the period to which the payment relates, or pay an amount as determined under the new sub-rule (3A). The new rule has laid down the formula in terms of which, the portion of the common credit attributable to the exempted services would have to be reversed…but about this highly complicated formula requiring arithmetical skills to understand, later..

The newly inserted Explanation 3 reads as under:

"For the purposes of this rule, exempted services as defined in clause (l) of rule 2 shall include an activity, which is not a 'service' as defined in section 65B(44) of the Finance Act, 1994."

This explanation is very dangerously worded, inasmuch as, any activity that is not treated as a 'service' under Section 65B(44) of the Finance Act, 1994 will be treated as an exempted service for the purpose Rule 6(3) and consequently, the quantum of the common credit attributable to exempted services that would need to be reversed, would go up significantly.

A reading of this new Explanation 3 would suggest that, activities such as sale of immovable property, interest income, income from actionable claims, etc. which are specifically mentioned in the exclusive part of the definition of 'service' under Section 65B(44) of the Finance Act, 1994 would get treated as exempted services. Thus, for a real estate developer, the activities involving receipt of interest income, proceeds from sale of immovable property, etc. would get treated as exempted services and the quantum of credit that would need to be reversed under Rule 6(3) would go up substantially.

Be that as it may…the new Explanation 3, as it is worded, also could lead to certain absurd situations wherein, even a pure sale transaction could get treated as an exempted service. Thus, if a manufacturer sells one of its office buildings, the sale proceeds could be treated as 'exempted services' necessitating a reversal of the common credit.

As it stands, even the sale of goods could get treated as exempted services, as the activity of sales can be treated as an activity, which is not a service. Taking the example of a car manufacturer who sells cars and also renders repair services of cars sold, the value of the cars sold, being an activity, could be treated as exempted services, resulting in a larger component of the common credit being required to be reversed.

Taking this discussion forward…. In the case of a works contractor, who is treated as a seller of goods as also a provided of services (to the extent of the 'service' portion of the works contract), the sale portion in respect of which, VAT is paid, could get treated as 'exempted services' for the purpose of Rule 6(3)

As TIOL readers can see…the new explanation is dangerously worded and could result in a significant increase in the quantum of the common credit to be reversed under Rule 6(3). Industry Associations would do well to ask for this new definition of 'exempted services' for the limited purpose of Rule 6(3) to be scrapped. One is not able to understand the rationale for this development, except to satisfy the sadistic pleasure of some Babus sitting in North Block.

If the Department interprets this new definition of exempted services to include sale value of goods, etc., it should be prepared to face litigation including issues challenging the constitutional validity of this new development, as in my strong view, the service tax law cannot get into issues concerning sale of goods, immovable property, etc.

Of course, sub-rule (3B) continues to give the benefit to banks and financial institutions to have the option of paying, on a monthly basis, an amount equal to 50% of the credit availed on inputs and input services in that month.

Before concluding….

One benefit flowing out of the substituted Rule 6(3)/(3A) is that, the default rule would be the reversal of the proportionate common credit, if the manufacturer/service provided does not intimate the Department of his choice as to whether he would want to go under the reversal route of elect to pay 6%/7% of the value of exempted services. In the current system, the Department has been insisting that the manufacturer/service provider should pay service tax at the percentages specified under sub-rule (3A), in case he has not intimated the Department of his choice. Further, under the substituted rule, it is clearly mentioned that the credit attributable to taxable services would not form part of the common credit necessitating the reversal process. This has been effected probably to get over the effect arising out of the Mumbai CESTAT decision in THYSSENKRUPP INDUSTRIES (I) PVT LTD Vs COMMISSIONER OF CENTRAL XCISE, PUNE reported in - 2014-TIOL-1825-CESTAT-MUM, wherein, the Tribunal had held that, the credit that would need to be considered for reversal under Rule 6(3A) would be the total credit and not the common credit, in the absence of an amendment to the statute. The Government has rightly responded, in what could be termed as an industry friendly move.

Till now, many assessees have been taking the view than an activity that cannot be considered a service in the first place, cannot also be considered as an exempted service, for purposes of reversal of common credit. This view can no longer hold.

Even the current version of Rule 6(3) has been so confusing that many Audit Teams have thought it fit not to look into the reversal of common credit. The new formula read with the amended definition of 'exempted services' is bound to confuse matters further. In my view, the onus would be on the Department to prove that, some credit of inputs and/or input services has been used for providing the activities that would now be covered under the amended definition of 'exempted services' and without this, the assessee can take a justifiable stand that, he is not required to reverse the proportionate credit.

As a Chartered Accountant, I found it difficult to understand the new formula, even after several rounds of reading. It is anybody's guess as to how the hapless assessee would understand the new law relating to reversal of common credit attributable to exempted services.

These developments do not augur well for a Government that keeps talking of 'ease of doing business'.

Lastly…. we must bear in mind that the new sub-rules have been 'substituted' with effect from 1-4-2016. As students of law, we know that the effect of a substitution is that, it changes the law from the time the relevant provisions have been in the statute. Thus, can the Department seek to apply the new definition of 'exempted services', vis-à-vis Rules 6(3)/(3A) for the periods earlier to 1-4-2016? The assessee can always fight these attempts by taking the view that, being a retrograde provision seriously affecting the rights of the assessee, the provision cannot be retrospectively applied. Of course, the assessee can also take the view that the other positive effects arising out of the Rule including the default option being the reversal of the common credit, have to be retrospectively applied, being beneficial provisions.

Cannot all the bright minds in the TRU come together and carve out a simple yet practical rule 6 of CCR?